The Buffett Rule: Right Goal, Wrong Tool

ON Monday, while many of us were scrambling to finish our tax returns, the Senate took up the Fair Share tax, which would require people with incomes over $2 million to pay an income tax rate of at least 30 percent. (The tax would be phased in between $1 million and $2 million of income.) The tax is sometimes called the Buffett Rule, after the billionaire investor Warren E. Buffett, who pointed out that he pays a lower tax rate than his secretary because most of his income comes from lightly taxed capital gains and dividends.

It’s good politics: most Americans believe the rich do not pay enough tax. President Obama has said that the Buffett Rule is a principle for tax reform, and heaven knows that the tax code needs an overhaul. But as part of such reform, we should correct the underlying defects that let multimillionaires like Mr. Buffett and Mitt Romney pay relatively low taxes — namely, those lightly taxed capital gains and dividends.

The Fair Share tax is not the right tool for this job. It is bad policy. If it became law, it would needlessly complicate taxes and create new inequities. In so doing, it would repeat an egregious error made 43 years ago when Congress created the first minimum tax in a poorly executed effort to rein in tax breaks for millionaires.

Back in 1969, Americans were outraged to learn that 155 high-income taxpayers had completely avoided the income tax. Congress could have responded by closing the loopholes that made this possible, but that would have upset wealthy campaign donors, many of whom prized such loopholes. So instead Congress created an additional “minimum tax” intended to make sure that rich people did not embarrass Congress by taking too much advantage of the tax loopholes that it had created.

Like the Fair Share tax, this minimum tax was originally aimed at people earning over $1 million (in current dollars). But because it wasn’t adjusted for inflation (among other problems), it gradually became the bane of the upper middle class, especially for such families with lots of kids in high-tax states. It morphed over time to become the dreaded “alternative minimum tax.” Today you are 50 percent more likely to be hit by this tax if you’re earning between $100,000 and $200,000 than if you earn $1 million or more.

The Fair Share tax differs from the alternative minimum tax because, at least for now, it targets higher-income people and is adjusted for inflation. But it is similar to the alternative minimum tax in that it creates needless complexities and inequities. For example, imagine two elite lawyers, each making $999,000, who are considering marrying. They would owe no Fair Share tax if they stayed single but could owe tens or even hundreds of thousands of dollars in additional tax if they married.

Or consider if you were on the cusp of paying the Fair Share tax: you wouldn’t know at the beginning of the year whether your capital gains would be taxed at a rate of 30 percent or 15 percent; it would depend on whether you were ultimately hit by the tax.

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A supporter of the Fair Share tax might counter that we shouldn’t worry about complexities and marriage penalties for the über-rich, but remember that the alternative minimum tax started as a tax on millionaires, too.

More fundamental is that the idea of three different sets of tax rules — regular tax and alternative minimum tax and fair share tax — makes no sense. One set of rules should apply to everyone, and if we close some loopholes, a reformed tax code could satisfy the goal of the Buffett Rule.

Specifically, we should fix the regular income tax to eliminate or curtail the tax loopholes that let rich people avoid tax, especially the lower tax rates on capital gains and dividends. And while it’s true that taxing capital gains at rates up to 35 percent (the current top income tax rate) might be counterproductive (because many investors would choose to hold on to their shares rather than pay the tax), there are other options. For instance, the top rate on capital gains could be raised from the current 15 percent to 28 percent — the rate set by Ronald Reagan’s Tax Reform Act of 1986, but undone in stages by tax changes under the administrations of Bill Clinton and George W. Bush.

A top-to-bottom income tax reform is the best choice. That approach was supported by a majority of the Bowles-Simpson deficit-reduction commission impaneled by President Obama. By eliminating most tax subsidies (like the deduction for state and local taxes), the commission was able to cut the top income tax rate to 28 percent, eliminate the alternative minimum tax and tax capital gains and dividends at the same rate as ordinary income while increasing overall tax revenues. That approach would also make the tax system much simpler.

If that is what the Buffett Rule means, I’m all for it. But we don’t need a second alternative minimum tax, not even for millionaires.

Leonard E. Burman, a professor of public affairs at the Maxwell School of Syracuse University, is the author of “The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed.”